There is a worrying trend that is growing in my email & linkedIn inbox i.e. the rise of “boutique” investment bankers representing startups that are raising their first round of investment capital.
What use does a banker serve at seed stage?
I am not against the idea of hiring investment bankers to facilitate transactions (Artha has its inhouse renewable IB, Artha Energy Resources) but it is the use of bankers to raise the first round of capital that is worrisome. A banker is useful when the transaction is large enough or complicated enough to requisite the use of their expertise in finding the target investors and facilitating the smooth closure of the transaction. What use does a banker serve at seed stage?
When I see, a banker representing a seed startup it tells me one of five scenarios is in play:
- The entrepreneur does not know how to represent his/her venture
- The entrepreneur does not know how to negotiate
- The entrepreneur has been around the block and no one will fund him/her
- The entrepreneur is desperate
- The entrepreneur isn’t full time on the venture
As you can imagine not one or even a combination of these reasons is good for the startup and its founding team. The encouragement of getting a banker to represent your startup will quickly dissipate when the experienced and leading early stage investors shun the startup. Today many investors are questioning the role played by angel networks in deal facilitation so the questions for the role of a banker are exponentially bigger.
My own experience with early stage investment bankers has not been encouraging.
My own experience with early stage investment bankers has not been encouraging. First I don’t think any banker worth their weight will pursue the miniscule transaction sizes in early stage fundraising. The effort (fortunately) remains the same for the banker so it makes infinitely better business sense for the banker to pursue larger transaction sizes. As banker’s remuneration is typically a percentage of the transaction, they have an incentive to increase the size of the transaction to increase their fees. However, this does not work well for early stage ventures as the need the funds and network of angel investors as of yesterday and the banker muddies the water in their own pursuit of profit.
Most discouragingly early stage bankers don’t come from the early stage space so they do not understand the valuation ranges for early stage deals, the typical deal sizes, the psyche of early stage investors and even how the entire system works. Their modus operandi as I have seen it is to promise an unearthly raise at a beastly valuation for the startup (yahoo!), draw up a mandate at the valuation, charge a small commitment fee and then start investor hunting with gusto. There is initial success with investors who are new to the early stage ecosystem. Unfortunately, those investors are new but aren’t gullible so they forward these deals to the us and we outright reject the proposition when we see what the banker has done. Eventually the banker runs out of steam (and money) and gives up on the deal blaming the investors who don’t understand the value of the entrepreneur.
There is initial success with investors who are new to the early stage ecosystem.
Unfortunately, what the entrepreneur does not know is that they created a barrier between them and use with an unrequired banker whose own motivation killed the transaction.